Bitcoin 101: The new gold or just a flash in the pan?

Bitcoin: New gold or flash in the pan?

The value and volume of trading in Bitcoin, the virtual currency, has risen since the Cyprus banking crisis, with speculators betting on more money coming into the Bitcoin market. The market is worth more than US$1-billion and is gaining attention from financial firms. “With confidence in this Bitcoin potentially increasing, the market actually starts building up its intrinsic value as a means of exchange, which might eventually make it potentially more stable in the long term,” said Sebastien Galy, a currency strategist at Societe Generale. Below, we take a deeper look at the currency the whole world is buzzing about.

We have no idea when the music will stop but at some point there will be a moment when it ends in tears, and people will wonder why they paid 40% more for something than what it was selling at the day before. Continue reading . . .

Q: So I’m starting to hear a lot about these Bitcoins. What are they?

A: A money supply, or a virtual currency (although purists will argue about the definition of currency). Basically, you can use Bitcoins to buy items online. Bitcoin is not the first such system, but it is by far the most successful.

Q: Can I just conjure up some free Bitcoins online then?

A: Not exactly. Each Bitcoin is a piece of code generated through very slow computer processing, known as “mining”, requiring a lot of hardware and software. So there is a cost, and the price has previously moved in relation to that.

It has been argued that the system offers a built-in bounty to those who would attempt to subvert it.

Q: So how would I buy some of my own Bitcoins?

A: You choose a virtual wallet from one of the various providers. This means you can start to receive coins from other users, and send them onwards. You can buy Bitcoins on specialist online currency exchanges, and they also change hands over online marketplaces such as eBay.

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A: Because the price has exploded, going from just over $10 per Bitcoin last November, to over $140 earlier this week.

Blame the crisis in Cyprus (one entrepreneur is even planning to open a Bitcoin ATM there), crumbling faith in traditional currencies, or what you will – Bitcoin is in hyperinflation mode.

Q: What’s the attraction?

A: A key idea built into the Bitcoin system is that there is a limit of 21m Bitcoins that can be mined. Right now there are close to 11m in existence, with a market cap of over $1.4bn, according to estimates.

That is music to the ears of some worried about the debasement of currencies through central banks’ easing, who have embraced Bitcoin as a non-fiat currency, or form of “electronic gold”. You can now buy car stickers boasting: “I believe in honest money: gold, silver and Bitcoin.”

Advocates also like how Bitcoin removes the need for a central bank. Analysts have suggested that it offers a system that is built around trusting individuals, rather than institutions. Then, of course, there are those who don’t want their purchases to be easily traceable – including a criminal element.

Q:What are the downsides?

A: You mean apart from the fact that it could all be a bubble about to burst and you could lose any money invested? People are already talking about how to “short” Bitcoins – effectively trying to make a profit by betting on the price collapsing.

The whole system raises questions about its integrity, not least because the only reason the supply is finite is because the rules say so – as opposed to there being a physical limit to mining Bitcoins, as with gold.

Sebastien Galy, a currency analyst at Societe Generale, notes that Bitcoin has already been effectively revalued. “With far more rapid advances in the technology of processing than mining, the rules have already been changed to stop some form of mining which were too effective,” he wrote this week.

Then there is the threat posed to the system by internet hackers.

Q: Bubble or not, the person who came up with this must be enjoying his moment in the sun!

A: Er, maybe. We don’t actually know who created Bitcoin. Early details were published by someone using the name of Satoshi Nakamoto, thought to be a pseudonym. A community of developers now “runs” Bitcoin, as a free open-source project.

Q: What next?

A: Who knows? Bitcoin could just be the first of a new wave of e-currencies, which may or may not stick to the same rules. It may be in “bubble” mode now, but so was the internet not so long ago – and that’s still around.

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